The Spectrum of Hedge Fund Investors And A Roadmap To Effective Marketing

Aug 25 2010 | 9:15am ET

By Ron Suber, John Quartararo and Patrick McCurdy of Merlin Securities

Running a hedge fund has never been harder. Established managers are struggling simply to keep moving forward against increasing redemptions and perilous markets. New managers, on the other hand, are experiencing low single digit returns and are still under or near their high-water marks. Now more than ever, it is critical that hedge funds know the full spectrum of hedge fund investors, understand what each of those investors require, and tailor their marketing strategy accordingly.

The following chart provides a high-level overview of our four-stage roadmap to focusing on the appropriate investors at the appropriate time.

Click on chart for larger viewClick on chart for larger view

The Ten Types of Hedge Fund Investors

Along the left side of the above diagram are the 10 levels of hedge fund investors, arranged along a spectrum that begins with early-stage retail allocators and progresses through the various layers of opportunistic investors leading to the major institutions.

There are several general qualities that change as a fund progresses through the different levels of investors. For instance, at the lower end of the spectrum, investors are relatively more tolerant of risk, volatility, limited infrastructure and idiosyncratic performance. They are also more willing to invest in managers with limited assets under management and little or no performance records.

As funds begin targeting investors further along the spectrum, they find more risk aversion and the expectation that funds need to have established track records of consistent alpha and minimal volatility. At the top levels of the spectrum, investors will only consider funds that can demonstrate operational best practices and clearly articulate their “edge.”

In the full version of the white paper, Merlin examines each level of investor in greater detail, providing overviews of how they operate, when they should be accessed, and what their relative advantages and limitations are.

The Four Stages of a Hedge Fund’s Development

Along the bottom of the diagram are the four stages of a hedge fund’s lifecycle:

1. Launch and Initial Fundraising: This stage represents the very early days of a fund’s development, including the prelaunch activities of securing initial investment capital.

2. Getting Beyond Retail: Also relatively early in a fund’s lifecycle (i.e., within the first 180 days), managers at this stage have established a groove, the fund is functioning well and core personnel and systems are in place.

3. The Institutional Threshold: For most funds, this stage represents a significant hurdle. Managers at this level have successfully gotten several small institutional commitments, and now they are ready to break into the top tiers of institutional investors.

4. Major Institutional Fundraising: This final stage of development is only attainable once all of the earlier requirements are satisfied: the manager must be able to articulate their “edge,” adhere to best practices and demonstrate a significant track record of repeatable performance with minimal volatility. Even when all these conditions are met, getting institutional capital is difficult.

It is critical that funds understand which stage of development and growth best describes them and that they then focus their efforts on the appropriate targets. Just as seeders are inappropriate targets for a $10 billion fund, pensions are not the optimal target for a $1 million startup fund without a track record. Time spent marketing is valuable and should be treated as such.

The four stages serve as a guideline to understanding how much attention a fund should commit to attracting the right types of investors at the right times. Additionally, the stages can help managers think about what aspects of their marketing program need to be ramped up as they move through each level of the spectrum.

Generally speaking, managers need to demonstrate increasingly that their infrastructure is robust, their investment process and results are repeatable and that they truly are as committed to managing their business as they are to managing their fund.

Marketing Across the Stages

Once a fund determines which investors it should focus on, the next step is to establish a marketing program to effectively reach those targets. As funds progress through the stages of their development, there are a number of sales and communications activities that they need to ramp up at each stage. These include:

• Maintaining dialogue with existing clients for additional funding
• Encouraging existing clients to introduce new potential investors
• Consistent communication with strategic partners about business growth and fund performance
• Refining and improving investor letters and broadening the distribution list
• Upgrading the website
• Speaking and attending investor conferences
• Developing and fostering relationships with key industry media

The landscape has changed dramatically for hedge fund managers and the investment community over the past several years, as have the investment approaches of each level of the spectrum. The financial crisis has forced hedge fund managers to understand that they are no longer simply managing a fund, they are operating a business. This concept is key to moving up through the various levels of potential investors.

For managers seeking the next level of AUM, it is important to understand where the fund is in its lifecycle, which investors should be targeted and what each of those investors requires. Only then can a fund begin to organize its overall marketing strategy to meet the increasingly stringent requirements of today’s hedge fund investors.

View White Paper: The Spectrum of Hedge Fund Investors and a Roadmap to Effective Marketing

Ron Suber is senior partner and global head of sales and marketing at Merlin Securities; John Quartararo is partner, sales and marketing at Merlin; and Patrick McCurdy is partner and head of capital development at Merlin.

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